Paycheck Chronicles

From The Mailbag: Why Buying Doesn't Make Sense

One of the biggest financial questions in anyone's life is whether to buy a house or rent.  The question is even more complicated for military folks.  First, there is the third option to live on base.  Second, few military folks live somewhere long enough to make buying a home a good idea.  Third, many military families take advantage of a home loan guaranteed by the Department of Veterans Affairs, and choose not to make a down payment.  All three of these factors mean that buying a house is rarely a great financial decision for military families.

Dear Kate,

You often discourage military families from buying a house?  Why do you do that when a mortgage can be so much less expensive than rent?  We are pocketing almost $300 a month of our BAH because we bought.

Homeowner in Harker Heights

Oh, if only it were so simple.  The comparison between rent and a mortgage is just one small portion of the overall equation.

Dear Homeowner,

There are several financial reasons why I discourage military families from buying homes.  The military lifestyle means that a homebuyer is more likely to lose money and  more likely to become an accidental landlord.  Neither of these things are desirable outcomes.

I could write an entire book on this subject, but I'm going to try to keep it to a couple of hundred words.  There are three main reasons why buying a house is a bad idea for most military families:  the chances that you'll lose money at sale, the unforseen costs of home ownership, and the perils of landlording.

Profit or Loss At The Time of Sale

The basic premise of buying a house is that you don't want to lose money.   However, buying and selling a house come with some large transaction costs.  If nothing else, someone has to pay the transfer costs at both ends of the deal.  More likely, the seller will pay real estate commissions, and perhaps some of the buyer's closing costs.  Just as a rough ballpark, you should plan that selling a house will cost you about 10% of the sales price.

If selling a house costs 10% of the sales price, you'll have to have at least 10% equity in the house just to break even at the time of sale.  There are three reasons why may not happen:  too small a down payment, not enough time in the house to pay off much of the loan balance, or declines in market value.  While it is hard to anticipate declines in market value, military families are a distinct risk of having too small a down payment, not living in the house long enough to pay off much of the loan balance, or both.

Let's say you buy a house for $250,000.  You use a VA guaranteed home loan that permits you to buy with no money down, and roll the 2.15% funding fee into your purchase.  The day you buy the house, it is worth $250,000 and you owe $255,375.  Let's say your loan has a 4% interest rate.  The loan balance doesn't even fall below $250,000 until after your 15th payment!

Three years after purchasing your house, you get orders to move and you want to sell.  You expect the cost of selling to be about $25,000, meaning that your net proceeds of the sale will be $225,000.  Unfortunately, after three years of payments, your principal balance is still around $236,000.  If you sell the house for the exact same amount of money that you paid for it three years prior, you'd have to come to the closing with $11,000 to pay off the balance of the loan.

Of course, there is always the chance that the house will appreciate in value, or you can sell it for less than the average 10% selling costs.  On the other hand, the home values could decline, or you could get orders sooner than you expect, or it could require some expensive repair during the time that you own.  

On some level, everyone goes into a home purchase with their fingers crossed that it all works out.  Military families, however, are at greater risk for loss due to the prevalent use of low- or no-down payment loans and the short amount of time they are available to occupy the property.

Most military families don't have the financial reserves to take that sort of risk, and yet military folks buy houses every single day.  Sometimes it works out, but I hear from an awful lot of people for whom it has not ended as they hoped.

The Costs of Home Ownership

It's incredibly easy to underestimate the costs of owning a house.  When you're a renter, you're responsible for rent, utilities (sometimes), and the cost of repairing anything damaged by your negligence or mis-use.  When you're a homeowner, you're responsible for everything.  Landscaping, gutter cleaning, appliances, new roofs, tree roots through the sewer line, cracks in the chimney, new driveways, painting - the list goes on.  Owning a house is a never-ending expense.

One popular rule of thumb is that you should expect to spend about 1% of your home's value on repairs each year.  For our hypothetical $250,000 house, that would be $2,500 per year.  Of course, there will be plenty of years where repairs don't cost that much, then the year when the air conditioner goes out and the roof requires replacement and you've spent $15,000 to $20,000 in one month.

In addition to repairs, most homeowners are in some continual state of upgrade.  New window treatments, that awesome patio, or even just a better kitchen faucet - it adds up.  I don't know a single person who owns a home who doesn't have a list of projects they want to do.

Accidental Landlording

Being a professional landlord is a tough business under the best of circumstances.  Very few military families, unfortunately, are working under the best of circumstance.  More often, they can't sell their house because their loan balance is more than their property's value, or because the area near base has been overbuilt, so they turn to renting as a last resort.  The homes you buy for your family are rarely the most profitable rentals, and even rental that seems profitable is often a big expense once you thoroughly consider all the costs.

Even more importantly, landlording is a specific skillset, and most military families aren't professional landlords.  The drama and stress of owing a house, that might be states or countries away from your home, can be overwhelming.

Throw in the possibility of extended vacancies, damaging tenants, or other hazards, and many military landlords find that they don't really like owning a house after all.

I know you didn't ask for a novella, but it is a topic about which I am passionate.  The math just doesn't work out for most military families.

Kate

Homeownership can be a good thing.  However, military families should rarely consider it a smart financial decision. There are compelling reasons to buy a house, but saving money isn't usually one of them.

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